Costs, Activities, Estimation

Module 14
Cost Behavior,
Activity Analysis,
and Cost Estimation
Variable Costs
 Increases as activity increases

Proportional to activity
Equals zero dollars when activity is zero

Example:

Materials
Higher variable
costs per unit
create a
steeper line
slope.
Total
variable
costs (Y)
Variable cost: Y = bX
0
Total activity (X)
b = Variable cost per unit
Fixed Costs
Slope is zero,
represented by
a flat line.
Total
fixed
costs (Y)
Fixed cost: Y = a
0
Total activity (X)
a = Total fixed costs


No change as activity increases or decreases
Example: Depreciation
Mixed Costs



Increase in a linear fashion when activity increases
Positive in amount when activity is zero
Example: Maintenance
Contains both
fixed and
variable cost
elements.
Total
mixed
costs (Y)
Variable portion
Fixed portion
Mixed cost: Y = a + bX
0
Total activity (X)
b = Variable cost per unit
Step Costs


Increase in a step like fashion as activity increases
Example: Supervisors
Step cost: Y = ai
Total
step
costs (Y)
0
Total activity (X)
Relevant Range


A portion of a range of activity associated with
the fixed cost of the current or expected
capacity
A normal range of activity in which a company
expects to operate, where the fixed costs remain
linear, i.e., total cost remains the same
Classifying Fixed Costs
Classification depends on the immediate impact if
the company attempts to change the fixed costs.
Committed fixed costs,
known also as capacity
costs, are required to
maintain the current service
or production capacity or to
fill previous legal
Depreciation
Real-estate taxes
commitments.
Training
Advertising
Discretionary
fixed costs ,
known also as
managed fixed
costs, are set at a
fixed amount each
period by
management.
Cost Estimation

What is it?
The determination of the relationship between
activity and cost
 An important part of cost management


Identifying variable or fixed costs
Analyzing available accounting records
 Interviews


Purpose of cost estimation

Cost prediction

i.e., forecasting future costs
Estimating
Mixed Cost Components
Methods of estimating fixed and variable
cost components



High-low method
Scatter diagrams
Least-squares
regression analysis
Variable
Costs
Mixed
Costs
Fixed
Costs
High-Low Cost Estimation

Utilizes data from two time periods

A high activity period, and a low activity period
Step 1: Select a representative high point and a
representative low activity point.
Step 2: Determine variable costs per unit:
Variable Costs
=
Per Unit
Difference in total costs
Difference in activity
Step 3: Subtract total variable costs from total fixed
costs using either the high or low point:
Total Fixed Costs =
Total costs – [Variable cost per unit × number of units]
High-Low Example:
Variable Costs
Number of
Shipments
Low activity period
High activity period
January
February
March
April
8,600
9,800
11,600
11,200
Variable cost
$31,600 – $25,000
per unit (b) = 11,600 – 8,600
Packaging
Costs
$25,000
26,000
31,600
33,000
= $2.20
The variable cost of each unit produced is $2.20.
High Low Example Fixed Costs
Calculate fixed costs:
Variable cost per unit (b) = $2.20 per unit
a
=
Total costs – Variable costs
January
$25,000 = a + ($2.20 × 8,600 units)
a = $6,080
March
$31,600 = a + ($2.20 × 11,600 units)
a = $6,080
The same total fixed costs result using
either the high or low activity point.
Scatter Diagrams
Examine scatter diagram for abnormal data.
Use judgment on the cost line. Can draw any number
of lines…
• Plot data
• Draw line
through
points.
Least-Squares Regression





A mathematical technique to fit a unique costestimating equation to all the observed data
Minimizes the vertical squared difference
between the estimated and actual costs at each
data point
Technique generally reliable
Can estimate errors
Accomplished using
Microsoft Excel®
 Statistical software
 Some calculators

Least-Squares Criterion
The least-squares method minimizes the sum of all squared
vertical deviations between individual observations and the
cost-estimating line.
Cautions in Developing
Cost Estimate Equations

Managers are responsible for making decisions




Mathematical models do not make decisions; they
are tools to aid decision making
Not all data are based on normal operating
conditions, throw out the abnormal…
Nonlinear relationships could exist
Results should make sense and be explainable
Unit Level Activity
This activity is performed for each unit of
product produced or sold, variable on units.
Examples:
 Cost of raw materials
 Cost of cutting a component
 Cost of a box to package cereal
 Sales commission
Batch Level Activity
This activity is performed for each
batch of product produced or sold.
Examples:
 Cost of processing sales orders
 Cost of equipment setup
 Cost of moving a batch between work stations
 Cost of inspecting batches
Product Level Activity
This activity is performed to
support the production of each
different type of product.
Examples:
 Cost of product development
 Cost of product marketing such as
product-related advertising
 Cost of specialized equipment
Facility Level Activity
This activity is performed to maintain
general capabilities.
Examples:
 Cost of maintaining factory building
and grounds
 Cost of non-specialized equipment
 Cost of general advertising
 Cost of factory supervisor